How a rate rise would affect mortgages

Any homeowner on a variable-rate mortgage will take an immediate hit in the pocket if the Bank of England raises interest rates today.

But that’s only around one in ten households in the UK, compared to around 20% a decade ago.

That’s partly because more people have fixed mortgages today. It also reflects the generational divide - older people have paid off their mortgages and own outright, while many young adults haven’t been able to get onto the housing ladder at all.

Torsten Bell (@TorstenBell)

Big trends are 1) less of us own a home 2) more owners own outright (lucky people) 3) there has been a big move towards fixed rate mortgages pic.twitter.com/2t68yUdx3e

The combination of these three trends – falling home ownership, growing outright ownership, and the shift towards fixed rate mortgages – means that only around 11 per cent of families have variable rate mortgages in Britain today. And they have smaller mortgage balances than those that have fixed – an average of £70,000 compared to £96,000.

To estimate the overnight mortgage impact of a rate rise, we can look at what happens if we add 0.25 percentage points to the interest rates paid by the 11 per cent of families with non-fixed rate mortgages. The result is an average increase in repayments of families of £6.40 a month (or 1.3 per cent of their existing repayments). Spreading the cost across all mortgage holders, the average repayment increase is just £2.50 a month.

Eventually, a rate rise will feed through to more borrowers as fixed-rate mortgage deals are renewed.

Torsten Bell (@TorstenBell)

The impact will grow over time as people move off fixes and if rates rise further. Markets expect them to be just over 1% in 2021. pic.twitter.com/U7jw9nQOQA

But still, raising interest rates from 0.25% to 0.5% certainly isn’t a repeat of Black Wednesday in 1992, when rates were hiked from 10% to 15% (and back again, after Britain crashed out of the exchange-rate mechanism).

Fran Boait, Executive Director of Positive Money, warns that an interest rate hike today could be very damaging:

“A decision today to raise rates at a time when real wages are falling risks shortening the fuse on Britain’s ticking household debt time bomb.

The Bank of England needs new policy tools which can deliver a sustainable boost to incomes, such as QE for People.”

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Currently, the Bank’s QE (quantitative easing) programme has only bought government and corporate bonds, which has driven up their price and also fuelled the stock market rally.

Central banks claim that their QE programmes have propped up the economy and kept unemployment low, but critics argue that they also increased wealth inequality...and even created the economic conditions that led to the Brexit vote and Donald Trump’s presidency.

Greek philosopher and mathematician Pythagoras of Samos famously said that “Silence is better than unmeaning words”. This is something that the Bank of England’s Monetary Policy Committee (MPC) members have arguably neglected: they have repeatedly signalled a rise in their rock-bottom policy rate only to fail to delivery such a rise....

Prof Milas also agues that the Bank should NOT raise interest rates today, because it will create pressure to keep hiking until inflation has come down.

Fresh academic research has found that in the presence of rising economic uncertainty, monetary policy tightening becomes less effective. The reason is that elevated uncertainty motivates agents to postpone decisions until more precise information becomes available, and this cautiousness makes them less responsive to changes in the economic environment, including the interest rate. The implication for the UK, where Brexit related economic uncertainty is indeed on the rise, is that an interest rate hike of 25 basis points on Thursday will have a much smaller impact on inflation and GDP growth than conventional wisdom suggests.

This poses a challenging dilemma for MPC members. Do they hike in order to remain credible, or do they continue to ‘wait and see’? If the MPC vote to hike, subsequent hikes will be necessary in order to meet the inflation target over the medium term. This comes at the expense of depressing GDP growth further. Our view is to abstain until the uncertainty cloud of Brexit negotiations starts to clear. The MPC members should take Pythagoras’ advice and only signal with intent.

Today is a historic day for the Bank of England whether it raises interest rates or not, says Lee Wild, Head of Equity Strategy at Interactive Investor.

A hike will be the first in a decade; another month of stalemate will damage the credibility of both the central bank and Mark Carney as governor.

An overshoot on inflation is almost entirely down to the weak pound, but unemployment at a 42-year low and a slew of improving data reflect an economy more than capable of coping in a higher interest rate world.

But Wild also warns that the Bank must avoid damaging consumer confidence, which already looks fragile:

The timing isn’t great for families struggling with the lag in wages growth to inflation, and who are now beginning to plan their Christmas budgets. Brexit is already causing many to rethink their spending, so rate-setters must tread carefully to avoid a policy mistake further down the line.